Question

Consider a firm with an EBIT of $565,000. The firm finances its assets with $1,150,000 debt (costing 5.9 percent) and 215,000 shares of stock selling at $14.00 per share. The firm is considering increasing its debt by $900,000, using the proceeds to buy back 90,000 shares of stock. The firm is in the 30 percent tax bracket. The change in capital structure will have no effect on the operations of the firm. Thus, EBIT will remain at $565,000.

Calculate the change in the firm’s EPS from this change in capital structure.

EPS before
EPS after
Difference

Answer 1

A	Capital Structure
		Present	Revised
	Debt @ 5.9%	$        1,150,000	$        250,000
	Equity	215,000 Shares	125,000 Shares
B	Computation of EPS:
	EBIT	$            565,000	$        565,000
	Less: Interest (Debt * 5.9%)	$              67,850	$          14,750
	Earnings Before Taxes	$            497,150	$        550,250
	Less: Taxes	$            149,145	$        165,075
	EAT	$            348,005	$        385,175
	No. of Equity Shares Outstanding	$            215,000	$        125,000
	EPS	$                   1.62	$               3.08
	EPS Before	$                   1.62
	EPS after	$                   3.08
	Change in EPS	$                   1.46	Increase